There's been a huge divergence in the fortunes of United Parcel Service (NYSE: UPS) and FedEx (NYSE: FDX) over the past year. UPS's stock has outperformed its rival's by over 30% in the last 12 months, and its 18% rise so far in 2019 stands in stark contrast to FedEx's decline of around 2%. Given that, the natural question for investors is, why is UPS significantly besting FedEx in terms of share price performance?
It's not just about end markets
Both companies are feeling the chill of slowing global trade growth, which has negatively impacted international shipping volumes, but it's here where the similarities end in 2019. Whereas FedEx's management has been highly vocal in blaming the impact of weakening end markets, UPS's has taken it on the chin. So what's the key difference between the two?
Image source: Getty Images.
In the end, it comes down to operational execution and, equally important, the difference between investors' prior perceptions of the two companies' ability to deliver. In a nutshell, FedEx's execution hasn't lived up to its previous standards. By contrast, there's a real sense that UPS's management has taken the bull by the horns, and is now well on its way to achieving its transformational aims.
Why FedEx was expected to do better
At the start of 2018, FedEx was seen as the higher-quality company by most investors. While UPS had repeatedly struggled to deal with the vagaries of peak delivery periods during holiday seasons, FedEx's network had proved more than capable of dealing with those surges.
Handling peak demand is not an issue to be taken lightly for these logistics giants. It boils down to having the capacity in place to meet your commitments during a handful of extraordinarily busy days each year -- and it can be hard to predict exactly which ones they'll be. Create too much excess capacity, and you're wasting money with no return; too little, and you'll need to purchase costly third-party transportation -- and perhaps disappoint a lot of people waiting for packages. UPS experienced both scenarios in recent years.
There are probably two reasons why FedEx was seen as outperforming UPS on peak delivery. First, FedEx operates separate air and ground networks, which is seen as giving it greater flexibility in dealing with peak demand periods. (UPS's networks are integrated.) Second, FedEx's history as a company focused on express deliveries means it has significant scale where it needs it. To see how that difference arose, consider the history of capital spending at both companies.
FedEx's reputation was strong enough that in 2017, the market shrugged off the impact of the NotPetya malware attack on TNT Express (a major European delivery company that FedEx bought in 2016). Investors continued to believe FedEx would achieve its plan of improving express operating income by $1.2 billion to $1.5 billion annually by 2020.
Moreover, come the first quarter of 2018 (after yet another disappointing holiday-season fiscal performance), UPS was forced to announce a significant ramp-up of capital expenditures in order to support e-commerce growth -- a de facto admission that it had underspent previously.
What's changed since then
The period that followed has not been kind to FedEx.
First, it had to back off its plan to boost profitability at TNT Express, due to the global slowdown in trade, and the lingering impact of NotPetya, which cost the company a lot of higher-margin work. More recently, FedEx decided to essentially sever ties with Amazon.com (NASDAQ: AMZN) -- in June, it announced it would not renew its express shipping contract with the e-commerce giant, and last week, it said it would let its domestic ground shipping contract lapse at the end of August, too. While that may be a reasonable long-term strategic choice for the shipper, the market is expecting it to have a negative impact, at least in the near term. Simply put, FedEx has had operational challenges in the last year or so.
Meanwhile, UPS has won plaudits for successfully executing its transformational strategy of investing to focus on international high-growth markets, global e-commerce, healthcare deliveries, and small and medium-sized businesses.
UPS CEO David Abney lauded those improvements during the recent second-quarter earnings call. "[O]ur transformation initiatives are producing positive operating leverage and improved profit, signifying an important turning point for UPS during 2019," he said.
He has a point. As the data below makes clear, UPS's total and domestic package segment revenue increases are being outpaced by profit increases.
First Half 2019
Domestic package revenue
Domestic package profit
Data source: UPS presentations.
And management reaffirmed its full-year earnings guidance for diluted EPS in the range of $7.45 to $7.75.
What it means to investors
UPS is undoubtedly making progress, but it's too soon to say whether it has solved the conundrum of how to deal with the pressure that burgeoning e-commerce deliveries put on margins -- a successful peak delivery season would help allay investors' concerns. Meanwhile, FedEx too must deal with the challenges and opportunities of rising e-commerce demand, but it also must find a way to successfully integrate TNT Express into its operations.
Cautious investors may prefer to avoid either of these stocks until the companies convincingly demonstrate they can grow their margins in parallel with volume from e-commerce deliveries. However, of the two, UPS is clearly on a better track right now.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Lee Samaha has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and FedEx. The Motley Fool has a disclosure policy.
This article was originally published on Fool.com